Is the U.S. stock market an economically efficient market? Explain.
We first try to understand what is the meaning of efficient
market, what will is the condition in the US.
Market Efficiency:-
Market efficiency refers to the degree to which market prices reflect all available, relevant information. If markets are efficient, then all information is already incorporated into prices, and so there is no way to "beat" the market because there are no undervalued or overvalued securities available.
The term was taken from a paper written in 1970 by economist
Eugene Fama, however Fama himself acknowledges that the term is a
bit misleading because no one has a clear definition of how to
perfectly define or precisely measure this thing called market
efficiency. Despite such limitations, the term is used in referring
to what Fama is best known for, the efficient market hypothesis
(EMH).
The EMH states that an investor can't outperform the market, and
that market anomalies should not exist because they will
immediately be arbitraged away. Fama later won the Nobel Prize for
his efforts. Investors who agree with this theory tend to buy index
funds that track overall market performance and are proponents of
passive portfolio management.
At its core, market efficiency is the ability of markets to
incorporate information that provides the maximum amount of
opportunities to purchasers and sellers of securities to effect
transactions without increasing transaction costs. Whether or not
markets such as the U.S. stock market are efficient, or to what
degree, is a heated topic of debate among academics and
practitioners.
An Example of an Efficient Market
While there are investors who believe in both sides of the EMH,
there is real-world proof that wider dissemination of financial
information affects securities prices and makes a market more
efficient.
For example, the passing of the Sarbanes-Oxley Act of 2002, which required greater financial transparency for publicly traded companies, saw a decline in equity market volatility after a company released a quarterly report. It was found that financial statements were deemed to be more credible, thus making the information more reliable and generating more confidence in the stated price of a security. There are fewer surprises, so the reactions to earnings reports are smaller. This change in volatility pattern shows that the passing of the Sarbanes-Oxley Act and its information requirements made the market more efficient. This can be considered a confirmation of the EMH in that increasing the quality and reliability of financial statements is a way of lowering transaction costs.
Other examples of efficiency arise when perceived market
anomalies become widely known and then subsequently disappear. For
instance, it was once the case that when a stock was added to an
index such as the S&P 500 for the first time, there would be a
large boost to that share's price simply because it became part of
the index and not because of any new change in the company's
fundamentals. This index effect anomaly became widely reported and
known, and has since largely disappeared as a result. This means
that as information increases, markets become more efficient and
anomalies are reduced.
The efficient market hypothesis (EMH) maintains that all stocks are
perfectly priced according to their inherent investment properties,
the knowledge of which all market participants possess equally.
Financial theories are subjective. In other words, there are no
proven laws in finance.Aug 15, 2019.
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